Materiality and the relationship it has with risk Essay

Materiality construct is a chief construct for hearers to take into consideration when be aftering an audit, before even looking at the fiscal statements. As materiality has no set regulations for every client or direction ; it is entirely dependent on the hearer ‘s opinion and experience they have in the concerns sector, which they believe to be the right degree to put materiality at. The hearer must establish an sentiment on histories given to them by the direction ; it is the direction ‘s responsibility to give a true and just set of fiscal histories to the hearer, as the hearer does non look for fraud they merely look for misstatement and hazard.

However, Materiality is merely taken into history if it is big plenty. As a & A ; lb ; 1,000 stock list figure may non be that stuff when the company turnover is & A ; lb ; 1,000,000. As it would be a waste of clip concentrating on such a little figure which would hold a little sum of hazard for the overall fiscal statements. But the hearer must take into history ‘creeping materiality ‘ as one little figure may non be material but tonss of little misstated figures might be material, so the hearer must make up one’s mind to utilize sampling or analytical processs to cut down the hazard of this go oning. Thus the hearer must look at single histories and the whole fiscal statements to give a just sentiment of the histories to the stockholders. The hearer must take into history ( ISA 320, paragraph 2, page 323 ) which states ‘Misstatements, including skips, are considered to be material if they, separately or in the sum, could moderately be expected to act upon the economic determinations of users taken on the footing of the fiscal statements. ‘ So the hearer must do certain that figures such as liabilities and disbursals are non misstated as they may give more admirable net income figures therefore investors and stockholders will be happy. Besides losingss could be stated as direction may be under menace from a coup d’etat, therefore doing the fiscal statements look unwanted.

Hazard in an audit is difficult to pull off as some material misstatement will stay undetected, as the hearers are unable to look into everything, this is why the choose a degree of hazard before they start the audit so they can merely look into certain figures in the fiscal statements. In ( Modern auditing, Graham W Cosserat, page 207 ) it states ‘Audit hazard is the hazard of the hearers giving an inappropriate sentiment on the fiscal statements. ‘ This may be caused by the hearer being given misstated fiscal histories or they may hold non followed process right. However this is non the lone hazard hearers may meet as hearers must take into history concern hazard, as the clients may be changing histories to do the hearer and stockholders believe that the concern will go on in operations, i.e. traveling concern. A premier illustration of this go oning in concern is Caparo industries plc v Dickman which is stated in ( Business Law, Ewan McIntyre, 4th edition, page 382 ) in which investors relied on hearer ‘s histories of the company, in which they invested. The company showed a net income but in world the company was really doing a loss, so the histories were misstated and did non demo a true and just position of the company ‘s fiscal place.

Audit hazard is comprised of three workings, which are Inherent, control and sensing hazard. Inherent hazard is seeking to work out the sums stated in the histories, as some histories and industries sectors are difficult to gauge, for illustration oil companies may gauge they have big sums of oil in their militias but may merely hold a little sum therefore cut downing future net incomes. However if good controls are in topographic point and good direction moralss and unity so audit hazard can be reduced therefore the impact of built-in hazard is less terrible and the histories will go more material. Control hazard is based on the internal controls of a company of which can ne’er be put at nothing, as there is ever human mistake involved, this is why effectual controls must be put in topographic point and systematically measuring for hazard, such as bank rapprochements. Auditor will desire directors to be built-in and ethical in the manner they run and check their internal controls as if they seem non to be so the hearer may hold cause for concern, as direction demands to be argus-eyed with controls to maintain down hazard therefore doing the fiscal history stuff and dependable otherwise such incidents may go on such as. Detection hazard is when the hearers may non admit all of the stuff misstatements in the fiscal histories and the hearer is able to put a degree that they wish to lodge to. Using all of these workings the hearer is able to fling the fiscal histories if one of the hazards are excessively high such as controls are non being monitored and director ‘s moralss are low, the histories may be misstated.

The relationship between materiality and hazard is an reverse relationship as hazard is lowered materiality rises, which is what the hearer and stockholders want, as they will hold a dependable set of history but this is non east to accomplish. A chief job for hearers is the relationship they have with direction, as to transport out a audit, the hearer must give a indifferent position about the histories, nevertheless as the ‘agency theory ‘ Tells us that directors are caught in the center between directors and stockholders. Hearers must non hold a particular relationship with direction, as direction may set force per unit area on the hearer or offer payoffs to alter their sentiments. So organizing a relationship keeps hazard down, nevertheless the hearer must utilize the histories given to them by direction therefore the hearer must believe the direction are moving ethically and built-in in running the concern. It is the hearers own professional judgement to make up one’s mind if the direction are giving true and just histories, as some direction may be changing the histories so that they can maintain their occupations or excessively receive wagess for hitting marks, it would be a bad thought for a hearer to take on a client with features such as these as the traveling concern of the company would be low and consequence the hearer. If direction are systematically look intoing controls hazard will be lower therefore doing materiality higher in the histories. However the hearer can non alter the controls in a concern, they can merely propose other ways to transport out the internal controls. So finally to maintain hazard low direction are the 1s to make this which does non assist the hearer in his sentiment of the histories.

One manner hearers can maintain hazard down and materiality high is to garner grounds of the fiscal histories, such as traveling and personally look intoing assets stated on the fiscal histories and appreciating them if need be. This type of sample proving supports risk down, as tonss of single misstated histories, i.e. ‘creeping materiality ‘ can alter the materiality of the histories. An hearer is able to look at old old ages histories, so if there are big alterations in the fiscal statements and no clear ground why, so there may be cause for concern or high hazard, but an hearer must be experienced in the industry sector as otherwise they will non understand different built-in hazards impacting the company and the external environment that may impact the company ‘s net incomes or losingss.